Financing for affordable seniors housing falls short despite strong consumer demand, forcing creative solutions
By Jane Adler
As the seniors housing industry grapples with how to create projects that most seniors can afford, the Low Income Housing Tax Credit (LIHTC) program continues to provide a much-needed source of equity to reduce development costs.
While competition for tax credits among developers remains strong, it’s becoming increasingly difficult to assemble financing packages for affordable projects because of the lack of programs to fill funding gaps.
Construction costs are rising too, along with operating expenses, making it difficult to build and operate a project that relies on affordable rents. Rising interest rates are another concern that could make the task of creating an affordable project even more difficult in the year ahead.
Even so, investor interest in the tax credits has never been more robust, with prices in 2015 reaching new highs (see sidebar). Investors favor seniors housing, in particular, because of low tenant turnover rates, high occupancies and low foreclosure rates. As a result, tax credit funds are available for development.
“The biggest concern now is that not enough affordable housing for seniors is being created,” says Beth Mullen, partner and head of the affordable housing industry practice for CohnReznick, a tax, accounting and advisory firm. “The resources available are not enough to keep up with consumer demand,” adds Mullen, who operates out of the firm’s Sacramento office.
Created in 1986, the LIHTC program has financed the construction or rehabilitation of 2.1 million units for lower-income households, according to “The State of the Nation’s Housing 2015” by the Joint Center for Housing Studies of Harvard University.
While multifamily developments account for most of the units, industry sources estimate that about 25 percent of the units are contained in seniors housing projects.
How tax credits work
The LIHTC program allows private investors to take a federal tax credit equal to a percentage of their contribution toward project development costs. The capital provided by the investor serves as project equity and helps to reduce the amount of debt needed to finance the project. That, in turn, lowers overall project costs and helps to keep rents low.
Two different tax credits are available: the so-called 9 percent tax credit that provides a 70 percent subsidy for certain costs; and the 4 percent credit for a 30 percent subsidy. The 4 percent and 9 percent figures refer to the annual percentage of project costs that investors may claim on federal tax returns for 10 years.
While the 4 percent credit is worth only about half as much as the 9 percent credit, the 4 percent credit is not
subject to the same allocation caps that apply to the 9 percent credit.
State housing agencies decide how the credits are allocated. In addition to the federal program, some states have their own LIHTC programs.
Demographics heighten the urgency
Demand for affordable seniors housing is expected to climb. According to a separate report by the Joint Center for Housing Studies of Harvard University, “Projecting Trends in Severely Cost-Burdened Renters: 2015–2025,” the number of households headed by persons between the ages of 65 and 74 paying more than half of their income for rent will rise by 42 percent by 2025. Among seniors age 75 and older, that number is projected to climb by 39 percent
by 2025.
Despite the demand, a growing problem for developers is the lack of additional financing programs needed to fully finance an LIHTC project. Harvard’s 2015 housing report shows that funding for the HOME program — an important source of gap financing for affordable and other housing programs — fell 62 percent between 2005 and 2015.
Also, funding for the federal Community Development Block Grant program, often used to help finance affordable projects, fell by about half between 2005 and 2015.
“The biggest challenge is gap financing,” says Michael Costa, president and CEO of Highridge Costa Housing Partners based in Gardena, Calif. “It’s a problem that prevails throughout the nation.”
The Great Recession strained city, state and federal budgets, he explains. Gap funding programs in some states were discontinued. California, for example, eliminated redevelopment agencies — a source of gap financing — to help balance the state’s general operating budget. “We’re scrambling to make deals work,” says Costa.
Since 1994, Highridge Costa has developed 90 senior apartment communities with LIHTC funds. The company currently owns 84 of those buildings, which contain a total of 8,402 units. About 7,000 of the units are located in California. The buildings are managed by nonprofit community-based organizations.
Each senior apartment building in the Highridge Costa portfolio has a waiting list of more than 500 applicants. Occupancy is currently 99.2 percent portfolio-wide. “I’ve never seen this large of a portfolio with an occupancy level that high,” says Costa.
Innovative solutions emerge
Successful deals continue to require creativity and familiarity with alternative funding sources.
Highridge Costa recently purchased the Seasons at Simi Valley, a 69-unit senior rental community built in 1999 located on nearly 3.8 acres in Simi Valley, Calif. The building contains 56 one-bedroom units and 13 two-bedroom units. The community is being rehabilitated and the work should be complete by March 2016.
Each unit will receive improvements valued at about $12,000. Building upgrades include a new master boiler system, repainting of the exterior, replacement of the existing windows, replacement of the landscaping with drought-tolerant plants, and new walking trails and recreation areas.
The complex funding package to purchase and rehabilitate the property includes a permanent loan for approximately $4.3 million, tax-exempt bond financing of about $6 million, and LIHTC equity of about $2.5 million.
Other financing sources include a $150,000 loan from the Golden State Finance Authority, the bond issuer. The property seller also holds a long-term note of about $2 million to be repaid by available cash flow.
Dealing with complexity
The FilBen Group, based in Rye Brook, N.Y., often uses tax credits to help finance the construction of assisted and independent living projects. “It’s really getting more and more complex,” says Michael Benenson, managing director at the FilBen Group. “These deals are hard to do.”
Benenson recalls a closing that took two days and involved 20 lawyers. “There are so many entities with an interest in a project with so many moving parts,” he says.
Benenson advises developers to assemble a well-rounded legal team that has experience with the LIHTC program and other funding sources. It’s also important to work with advisors who understand how the individual state allocates and manages the credits.
In one case, investors from Texas were buying tax credits on a project by FilBen in New York. But the investors and their legal team were unfamiliar with New York’s regulations regarding construction and operations. “Educating people is a timely and expensive process,” says Benenson.
The ultimate payoff is often worth the effort. Capital provider Lancaster Pollard was recently able to reduce annual debt payments by $60,000 on an affordable assisted living property.
Heritage Woods of Charleston is a 68-unit supportive living facility in Charleston, Ill. It is part of the state’s Supportive Living Program, which provides assisted living for low-income seniors by accepting Medicaid funds.
The building was originally financed using a guaranteed loan from the USDA Section 538 program and 9 percent low-income housing tax credits.
Because of the low leverage on the original loan due to the low-income housing tax credits, Columbus, Ohio-based Lancaster Pollard was able to refinance the loan for $4.3 million via the sale of a GNMA (Ginnie Mae) security, thereby reducing the debt service without any equity contribution from the borrower.
Fierce competition for tax credits
About six applicants vie for every tax credit allocation in California, says Costa, the executive from Highridge Costa. Seniors housing developers often compete against their counterparts in the multifamily sector for the credits.
In California, 10 percent of the allocations are reserved for seniors housing. “But not all states have that set-aside,” says Costa.
He formed a group along with other developers that lobbied to increase the set-aside for seniors housing to 25 percent. “We almost got that done this year,” says Costa. “People are starting to pay attention to the demographics.”
Developers feel squeezed
Building operating costs are rising. “It can be difficult to maintain the buildings,” says Costa. His company has a long-term investment horizon, holding the properties for at least 15 years to realize the full benefit of the tax credit allowance.
In order to generate funds to rehab older properties, Costa refinances the property using 4 percent tax credits, which are more readily available than 9 percent credits.
“We are focused on asset management,” says Costa, whose firm does not manage the properties. The company syndicates its own tax credits, however.
Rising development costs are a concern, say developers. At the same time, the state agencies that allocate the credits are becoming more demanding, asking developers to produce higher-quality projects at lower price tags.
Construction costs have risen more than 5 percent annually for the last two years, says Aaron Pechota, senior vice president of development at Cleveland, Ohio-based NRP Group.
“We’re in an inflationary environment.” He adds that labor shortages are cropping up in some markets, especially in Texas.
NRP develops, owns and manages both market-rate and affordable apartments, including 51 affordable projects for seniors. NRP recently financed two seniors projects with LIHTC funds:
n In June 2015, the $10 million Parsons Village Senior Apartments opened in Columbus, Ohio. The 56-unit building is located on the South Side of Columbus, an area earmarked for revitalization. A local nonprofit organization that partnered with the NRP Group developed the project. Tax credits totaled about $990,000.
n In September 2015, NRP broke ground on a $9 million senior apartment project located across from a light rail station in Cleveland. The 55-unit building, called A Place for Us, is designed for aging members of the LGBT community. Tax credits totaled about $850,000.
Trends to watch
Developers expect demand to grow for services to assist seniors aging in place in affordable apartments financed with low-income housing tax credits. Though many of the projects are not designed to provide services on site, there will be a need for more coordination with home health agencies and other service providers.
“Folks are trying to figure out how to create quasi-assisted living communities in the buildings they have,” says Pechota. “The question is: how do we pay for the services?”
States are experimenting with solutions. In Illinois, many of the buildings in the Supportive Living Program (assisted living for low-income seniors) are being financed with low-income housing tax credits. A Medicaid waiver provides money for the assisted living services for residents.
Other states are looking at ways to use Medicaid money to pay for assisted living services, which cost less than nursing home care.
“There’s been so much focus on assisted living for high-end users,” says Steve Kennedy, senior managing director at Lancaster Pollard.
Kennedy is bullish on the outlook for affordable assisted living because of the massive demand. “Tax credits will play a role,” he says.
Tax reform looms large
The big worry on the horizon is whether a major overhaul of the tax code could curtail the LIHTC program. A flat tax, for example, would end tax credits.
But no one expects tax reform to get a serious hearing in 2016 because of the upcoming presidential election. “Any reforms aren’t likely until 2017,” says Mullen at CohnReznick. “But we are keeping our eyes on Capitol Hill.”